Femsa Earnings: Strong Top Line but Lower Margins From High Labor Costs and Struggling Health Format

We are maintaining our $105 fair value estimate for narrow-moat Femsa after absorbing mixed 2023 results. Sales growth of 18% (adjusted for divestitures) met our estimate, but the 6% decline in operating income missed our projection for 1% growth. We attribute the profit shortfall to margin compression across retail formats due to high labor costs and a slower ramp-up in newer stores, both of which are fixable, in our view. We remain confident in the long-term outlook for the convenience and fuel formats as well as in bottling, but we see hurdles in regulations and consumer preferences for the struggling health format (5% of 2023 operating profit) and expect the firm to moderate its ambitions in the area. That said, our 10-year forecast for both sales CAGR and average operating margins in the high-single digits are still attainable. Shares look expensive, even after a 16% correction in the past week.